Supplier Impact Assessments (Kraljic's Segmentation Matrix)
⏲ 4-minute read | last updated 2 months, 3 weeks ago
If you've worked in procurement for any period, you should be familiar with evaluating supplier impact on your business with the Kraljic Segmentation Matrix (after Peter Kraljic - a former McKinsey consultant).
It’s an excellent way to think about relationships with supplier and their impact on your business. Here is the basic graph.
On the Y-Axis, you have “profitability”; on the X-Axis, you have “risk”.
- Profitability means how much this supplier impacts your company's profit (not “how much money does the supplier make”).
- Risk is an assessment of how impactful a supplier is to your business. Typically, this can be thought of as availability/volume/marketplace/level of competition for that particular supplier category. Fewer suppliers = less competition. Less competition = fewer alternatives. And fewer alternatives = ↑ risk if something goes wrong.
The Four Quadrants
The intersection of profitability and risk yields four distinct quadrants. All your Supplier relationships can be plotted on this graph somewhere. If you're new to a category (or an organization) it’s a good exercise to figure out where each one sits. This applies to all suppliers for any industry, but I'll use construction suppliers/trades as easy illustrative examples below.
Non-Critical
At the intersection of low profitability and low risk are non-critical suppliers.
- Profitability - They don’t significantly impact your business.
- Risk - They're easily replaceable.
- Advice - A mentor once told me “You should never hear from these guys, anytime you get a phone call, it should be them offering you a concession. If there’s any trouble, replace them and move on”. This makes sense - you shouldn’t spend much time with these suppliers, because overall the potential value to be gained is low/nonexistent. Out of the gate, these suppliers typically have low/compressed margins due to the nature of their industry and the level of existing competition - and you can’t squeeze water from a rock.
- Examples - interior cleaners, landscape companies. Think of those businesses that are on every corner, have low barriers to entry with (low startup capital costs).
Leverage
Next, there’s low risk but a high impact on profitability. These are your leverage suppliers.
- Profitability - These companies have the potential to significantly impact your companies profitability, so they need to be managed closely (and are worth your attention).
- Risk - What’s fun about suppliers that fall into this category is that there is still a lot of competition (meaning relatively low risk to the business).
- Advice - In contrast to non-critical suppliers, leverage suppliers present a valuable opportunity for effective negotiation and procurement strategies. There’s “juice to squeeze” (so to speak). Manage them closely, create a diverse set of suppliers, and focus on internal organization to lower switching costs. Leverage the competition that exists in the marketplace to your advantage and use should-costing methods, market analysis, and industry data to drive down costs. If existing suppliers are not cooperative or interested in working with you to create value and drive down costs, consider making a change.
- Examples - High (or higher) margin products like flooring and countertop distributors, drywall, insulation, and basic plumbing fixtures.
Bottleneck
At low profitability and high risk are your bottleneck suppliers.
- Profitability - These companies don't represent a large impact on overall profitability, but are typically considered "essential" to complete the project.
- Risk - They're high risk, due to (for one reason or another) low overall availability in the market.
- Advice - Manage the relationship closely, and work to develop as many new suppliers as possible. If alternatives are not immediately available, it could require more long-term, out-of-the-box thinking (like cost-sharing for new market entrants, leasing/purchase of warehouse space for higher-volume purchases, or longer contract terms with minimum spend commitments). It may require some extra upfront spending here to appropriately reduce risk.
- Examples - Windows, custom doors, specialty HVAC equipment, smart-home technologies, and higher-end appliances.
Strategic
Finally, at high profitability and high risk are your strategic suppliers.
- Profitability - These suppliers represent a significant impact on profitability due to them being high-value products that are critical to the project's success.
- Risk - They're high risk because of limited availability, and any disruption significantly impacts the project.
- Advice - Focus on relationships and create joint risk-management strategies. You should spend a lot of time with these vendors developing trust. Make mutual information sharing easy and reciprocal to gain insights into the broader industry. Use shared objectives (and share data) for forward demand planning.
- Examples - Lumber and concrete. Without lumber, you can't build a house. And without concrete, you don't have a place to build it!
Company vs. Market
You can identify where suppliers fall according to:
- The supplier base at your company, and;
- The "real life" supplier segmentation based on a full market of supplier participants
The difference between the two represents opportunity, or a chance to re-plot where a supplier falls on this graph. Increasing the diversity of suppliers for a particular category is one of the easiest ways to reduce risk. You also can address profit impact, but that generally requires a bit more creativity and is more impactful to other departments (think breaking up turnkey solutions, considering product redesigns, reengineering, or swapping for alternative products altogether).